Written by Sarah Foster – 11 min read – Edited By Brian Beers
The days of zero rates are quickly coming to an end.
The Federal Reserve looks poised in March to make it more expensive to borrow money for the first time since 2018, kicking off what’s likely to be the most aggressive tightening of monetary policy in recent memory as the central bank takes on surging inflation.
The ultimate question now is how high will interest rates go. If Wall Street’s views come to fruition, U.S. central bankers could hike rates at every meeting this year, possibly even backing a massive half-point hike for the first time in two decades.
The Fed’s actions have ripple effects on every aspect of your financial life, impacting how much you’re charged to borrow and how much you earn when saving. When the Fed’s rate rises, so too do rates on credit cards, home equity lines of credit (HELOCs), auto loans and adjustable-rate mortgages (ARM), as well as yields on certificates of deposit (CDs) and savings accounts.
Consumers can feel the Fed’s impact almost immediately. In some cases, lenders are already charging customers more to borrow, preempting any Fed moves.
There’s one bright spot to paying more for money this year: More expensive borrowing costs can also hopefully reverse today’s red-hot levels of inflation that have made it more expensive for consumers to afford everything from cars, gasoline and utilities to groceries, furniture and appliances.
But the bottom line is, acting now is likely in your best interest to ensure you’re well positioned to handle the one-two punch to your cost of living that is higher interest rates and soaring prices.
Here’s your 11-step plan for taking charge of your wallet before the Fed hikes rates.
1. Get a snapshot of your personal finances
Before you form a financial action plan, consumers should get an idea of where they’re at with their personal finances, including how much they have in both savings and debt.
“Plan down to the decimal point how this will impact your budget,” says Bruce McClary, spokesperson for the National Foundation for Credit Counseling. “We don’t know exactly how many rate hikes there are going to be, but the most important thing is going into this with a clear picture of where you stand financially.”
Print out statements from any account that’s housing liquid cash — or money that you could withdraw without penalty. Those are most likely savings accounts, but they could also be funds in a money market account or no-penalty CD. Even better, make a note of each account’s annual percentage yield (APY).
Next, make a list of your current debts, including your outstanding balance and the annual percentage rate (APR) you’re charged. Keep tabs on whether that debt has a fixed or variable rate and calculate how much you spend in interest each month.
Then, consider looking at your monthly budget and expenses, including how much money flows in and out of your wallet each month.
The goal of taking a hard look at your personal finances is to hopefully inform you of how fragile you might be in a rising-rate environment. You might also be able to find the debt that’s low-hanging fruit to eliminate, as well as identify budget cuts that you can make. Individuals who live outside of their means and borrow to fund their expenses will feel squeezed in a rising-rate environment.
2. Know what’s good debt and bad debt — and eliminate the latter
If you’re a homeowner with a fixed-rate mortgage, you’ll be safe when the Fed raises rates. But consumers with variable-rate and high-interest debt will want to act fast before the Fed starts hiking. They’ll be the borrowers who are hit the hardest.
“Anything you can do to pay off your balances faster and make adjustments in your budget, so you don’t have to rely on your lines of credit and carry debt from month to month, that’s the best strategy” when rates are on the rise, McClary says.
High-interest debt commonly comes from a credit card. Even when the Fed’s rate held near zero, the average credit card rate hovered close to 16 percent, according to Bankrate data. If you don’t pay off your balance in full each billing cycle, that’s likely costing you hundreds, if not thousands, of extra dollars a month.
A popular method for eliminating this so-called “bad” debt is consolidating your outstanding balance with a balance-transfer card. Once you know your monthly interest costs, compare that with any fees you could be charged to refinance that debt. Then, shop around for the best offer on the market. Most cards start borrowers out with a rate as low as zero percent for a specified number of months before transitioning them to the regular APR.
Consumers would also be wise to eliminate any variable-rate debts by refinancing into a fixed rate.
“You don’t want to be a sitting duck for higher interest rates on your credit card or home equity line of credit,” says Greg McBride, CFA, Bankrate chief financial analyst. “Fixed-rate debts like mortgages and car loans that are low and mid-to-single-digit rates — there’s not a whole lot of incentive to pay ahead on that when inflation is at 7 percent.”
That’s because the relatively low-cost debt can be a strong hedge against inflation. And simply put, you might be better off putting that money toward other avenues that meet your financial goals — such as saving or investing — than paying it off.
“The real value of that debt will decline in an inflationary environment,” says Gary Zimmerman, CEO of MaxMyInterest. “Since debt is a liability, when the value of your debt declines, you’re making money.”
3. Make sure you’re not missing out on any other opportunities to refinance
Shopping around will be one of the most important steps a consumer can take in a rising-rate environment.
Mortgage rates crossed 4 percent for the first time since 2019, and the record-low refinance rates of the coronavirus pandemic era might now be in the rearview mirror. Still, consumers might be able to find a rate on the market that’s lower than what they’re currently paying, depending on when they took out their loans. About 74 percent of homeowners hadn’t refinanced back in October 2021, a Bankrate survey found.
If you’re a homeowner, part of the reason for first noting the interest rate on your debt is to make sure you’re not leaving money on the table. If there’s an offer on the market lower than what you’re currently charged, the difference could shave hundreds off of your monthly payment, freeing up crucial cash as inflation eats into your wallet.
Another avenue where noting rates might be prudent: private student loan borrowers. Doing the same kind of comparison shopping might help you score the lowest rate possible before interest rates start their ascent again.
Federal student loan borrowers, however, will want to think twice about refinancing their debt. Doing so could mean giving up on important perks, such as the pandemic-era hardship forbearance. Federal student loan borrowers almost never feel any impact from Fed rate hikes because most loans have fixed rates.
4. Work on boosting your credit score
If there’s any factor that inhibits consumers’ ability to borrow cheaply more than the Fed, it’s their personal credit scores. Most of the time, financial companies save the best rate for the so-called “safest” borrowers: those with good-to-excellent credit scores and a reliable credit profile.
Improving your credit score means more than just reducing the interest you pay on credit card debt. It could also help you save throughout all aspects of your borrowing life, including on auto loans and mortgages.
To have the best credit score possible, concentrate on making all of your debt payments on time and keeping your credit utilization ratio as low as possible — the two factors with the biggest influence on how your rating is calculated.
5. Keep up frequent communication with your credit card issuers
If your credit card rate hasn’t changed after a significant improvement to your credit score, a crucial step in your financial plan should be opening up the channels of communication with your credit card issuer. Issuers might give you a new APR, NFCC’s McClary says. If they don’t, you’ll at least know it’s time to shop around or take advantage of a balance-transfer card.
“It’s sad how few people talk to their creditors when times are good because it’s when you have those conversations, you realize a lot of really great things you could be doing to save even more money,” he says.
Ahead of an active Fed cycle, it’s also worth looking over your cardholder agreement and making sure you’re aware of how your issuer calculates your APR.
Typically, rates on variable loans change within one to two billing cycles after a Fed rate hike. Credit card companies, by law, have to give cardholders a 45-days notice if they’re going to increase their cardholder’s interest rate. Yet, any rate increase is up to the creditor, meaning it’s not outside of your issuer’s purview to hike rates faster or sooner than the Fed.
“Credit card companies do have some latitude in deciding when and how much to increase a cardholder’s interest rates within the confines and constraints of the Card Act,” McClary says. “It’s in those areas that the details are going to be in the cardholder agreement.”
6. Don’t let low yields and high inflation keep you from saving
Next-to-nothing savings yields and soaring inflation might make consumers hesitant to sit on large piles of cash, but experts say it’s more important now than ever. In fact, the outlook might look even brighter once the Fed starts dialing back stimulus, especially if it slows inflation.
“If your cash has been in a savings account at 0.5 percent for the last two years, there’s no sense moving it now while we’re on the cusp of rates starting to move up,” McBride says. “That’s like wearing your seatbelt when the car is in the garage and taking it off once the car is on the road.”
An important part of any financial plan is having cash for emergencies. Experts typically recommend storing between six to nine months’ worth of expenses in a liquid and accessible account. That balance was never meant to bring you a hefty return.
“Building a rainy day fund is really important, even if the interest rate you’re earning on those funds is lower than the inflation rate,” says Mike Schenk, deputy chief advocacy officer at the Credit Union National Association. “Put a little bit into a savings account over time, and before you know it, you’ll have a chunk of savings that can give you a better night’s sleep at the very least.”
Better yet, think about your emergency fund as the difference between having to pay for unplanned expenses with a high-interest credit card.
“In that respect, cash is earning you a risk-free 16 percent,” Bankrate’s McBride says.
7. Shop around for the best yield
Be prepared to shop around regularly for the best savings yields on the market, even if it means moving your funds to a different bank to capitalize on a better return.
Online banks typically are able to reward their depositors with higher yields because they don’t have to pay the overhead associated with operating a brick-and-mortar financial institution. Even today, many online banks are offering yields 10 times the national average.
You shouldn’t sacrifice liquidity for yield chasing, but if an account on the market offers terms that fit your financial needs, nothing should stop you from going for it.
“Every month, a different bank is going to have the best rate,” says Zimmerman with MaxMyInterest. “Since an FDIC-insured savings account is a commodity, it doesn’t really matter which bank. The whole idea of, ‘I’m going to pick a bank,’ That doesn’t make any sense.”
8. Start recession-proofing your finance
Saving is crucial right now because it highlights the ultimate risk if the U.S. central bank gets rates wrong: It could ultimately end up slowing down economic growth, or worse — causing a recession.
A recession isn’t probable, but it’s possible: In the most recent tightening cycle between 2015 and 2018, the Fed hiked rates into a slowdown, ultimately walking back three of those hikes to give the financial system some juice again.
“Raising interest rates is putting the brakes on the economy,” Bankrate’s McBride says. “The harder they press the brakes, the sharper it’s going to slow down. The cumulative impact of ongoing rate hikes is where you’re likely to see a slowdown in economic activity and the labor market.”
Recessions aren’t always as severe as the coronavirus pandemic, the Great Recession or even the Great Depression almost a century ago. They do, however, mean increased joblessness, reduced hiring and market volatility.
All of that means it’s important to start thinking about how you’d stay afloat in a recession. The same financial advice for preparing for a rate hike applies here: Live within your means, eliminate your debts and make sure you’re able to cover a period of joblessness.
9. Given economic risks, mortgage rates might be volatile in the years ahead
The Fed doesn’t directly impact mortgage rates, which are instead pegged to the 10-year Treasury rate. Still, the same market forces influencing the Fed ultimately steer that benchmark yield, pointing to the likelihood that mortgage rates will climb in the years ahead.
Still, experts say that’s not always set in stone, especially with the prospect of an economic slowdown at the end of a rate-hiking cycle.
“If the Fed overcorrects and the economy starts to slow, then mortgage rates will come back down,” McBride says. “Be careful what you wish for because an economic slowdown — or worse, a recession — isn’t fun for anybody.”
10. Think about your career and income opportunities
When the cost of living rises, one of the best investments you can make is in yourself. Think about ways that you can increase your earnings opportunities over your lifetime, whether that’s by getting more training, education or increasing your skill set.
Joblessness is typically lower for those with a bachelor’s degree or higher — even during recessions, according to data from the Labor Department. Job hoppers are also rewarded in today’s strong job market with faster wage growth, according to data from the Atlanta Fed.
“You have to be looking down the road because what’s far more impactful to household finances than an increase in interest rates is a job loss or a significant decline in wealth,” McBride says. “Those are the types of things that happen in a recession.”
11. Pay no attention to market volatility if you’re investing for the long term
Higher rates typically cause market dysfunction. That’s partially by design: When the Fed raises rates, it wants to tighten financial conditions, soaking up extra liquidity in the marketplace.
Case in point: The S&P 500 is down about 10 percent to start the year, as investors grapple with the prospect of higher rates.
Still, that shouldn’t mean anything for long-term investors, especially those that put money into the markets by way of a retirement account. If you’re investing over a time horizon that spans decades, you’ll no doubt have to endure both booms and busts.
Remember: The only way to lock in a loss is to sell. Better yet, see volatile markets as a potential buying opportunity. Investing can also help you beat inflation, though it’s something you should think about mostly after you start saving.
“Investing does make sense because you will more than likely have to take a little bit of risk to earn returns that are higher than the inflation,” CUNA’s Schenk says.
Bottom line
How much rates rise this year is ultimately up to Fed policymakers. A committee of voters sets interest rates, meaning Chair Jerome Powell will have to steer officials with varying viewpoints to consensus.
Even if the Fed hikes rates by a quarter of a percentage point seven times this year, the federal funds rate would be in a target range of 1.75-2 percent, where it was in September 2019.
That means consumers can still expect borrowing rates to be at historic lows, even if they’re not as low as where they once were.
The ultimate goal with rate hikes is to give the economy a soft landing — slowing inflation, but not too much that it tips the economy into a recession.
“The crisis is easing, so it makes sense to take the policy foot off the gas to a certain extent, and maybe even to start tapping the brakes,” Schenk says. “It’s a very tricky balancing act. They’re basically operating on a knife’s edge.”
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